In which forms of business organization are the owners personally liable?

Most new businesses start out as sole proprietorships. This is the simplest form of ownership for a sole owner and requires little more than a tax ID number. However, when there are concerns over taxation or liability issues, or when the business has multiple owners, other organization types should be considered.

Which organization type is best for your business depends on a number of factors, including the type of business it is, the number of owners it has, and the degree of concern over taxation and liability issues.

Key Takeaways

• A sole proprietorship requires little more than a tax ID.
• A partnership is an agreement to share the business revenues. Each partner's share is taxed as personal income.
• A limited liability company is a partnership that shields each partner from personal liability for debts incurred by the business.
• The C corporation is a tax entity in and of itself and can lead to double taxation.
• An S corporation passes revenues directly to the partners, who report their shares as revenue.

Partnership

A partnership is a straightforward business organization type to create. It requires an agreement that may be verbal or written.

In a partnership, the owners manage and control the business, and all revenue from it flows directly through the business to the partners, who are then taxed based on their portions of the income.

The partners are personally liable for all debts and any liabilities that result from the operation of the business.

The sole proprietorship and the partnership are the most straightforward business organization types.

When one partner leaves the business, it is dissolved unless there is an agreement in place that allows it to continue. A business continuation agreement typically stipulates the terms under which a partner can transfer a share of the business for some financial consideration.

The same agreement should provide for the transfer of a deceased partner's share so that the surviving family members receive fair compensation from the remaining partners.

Limited Liability Company (LLC)

The creation of a limited liability company (LLC) requires an operating agreement and a state filing of articles of organization.

Like the principals in a partnership, the owners of an LLC have direct management control over the company, and the company is required to file an information return to the IRS. The owners file their own individual returns based on the revenue that flows to them directly through the business. The information return shows how much revenue was paid to each partner.

The primary difference between a partnership and an LLC is that the latter is designed to separate the business assets of the company from the personal assets of the owners. That insulates the owners from personal responsibility for the debts and liabilities of the company.

In terms of the sale or transfer of the business, a business continuation agreement is needed to ensure the smooth transfer of interests when one of the owners leaves or dies.

C Corporation and S Corporation

There are two types of corporation, the S corporation and the C corporation. Both are legal entities that are formalized with the filing of articles of incorporation with the state.

The primary difference between the two is in their tax structures:

• The C corporation is a tax entity in and of itself, so it files a tax return and is taxed based on the revenues of the business. Double taxation could occur when the shareholders or owners file individual returns based on any income they receive in the form of dividends from the corporation.
• An S corporation is similar to a partnership and LLC in that it files an informational return. However, the revenue flows directly to the shareholder owners, who then file individual returns.

In most other aspects, the two business structures are the same. In both cases, the business is controlled by a board of directors which is answerable to the shareholders. The board hires the senior management team. Business assets and liabilities belong to the company, and the sale or transfer of interests can be achieved by the sale of shares.

Ultimately the type of business organization selected comes down to the owners' level of concern over management control, liability exposure, tax issues, and business transfer issues.

Because of the tax and legal implications involved, the guidance of a qualified tax attorney is essential in selecting the most suitable form of ownership.

Limited liability is a type of legal structure for an organization where a corporate loss will not exceed the amount invested in a partnership or limited liability company (LLC). In other words, investors' and owners' private assets are not at risk if the company fails. In Germany, it's known as Gesellschaft mit beschränkter Haftung (GmbH).

The limited liability feature is one of the biggest advantages of investing in publicly listed companies. While a shareholder can participate wholly in the growth of a company, their liability is restricted to the amount of the investment in the company, even if it subsequently goes bankrupt and has remaining debt obligations.

Key Takeaways

• Limited liability is a legal structure of organizations that limits the extent of an economic loss to assets invested in the organization and that keeps the personal assets of investors and owners off-limits.
• Without limited liability as a legal precedent, many investors would be reluctant to acquire equity ownership in firms and entrepreneurs would be wary of undertaking a new venture.
• Several limited liability structures exist, such as limited liability partnerships (LLPs), limited liability companies (LLCs), and corporations.

How Limited Liability Works

When either an individual or a company functions with limited liability, this means that assets attributed to the associated individuals cannot be seized in an effort to repay debt obligations attributed to the company. Funds that were directly invested with the company, such as with the purchase of company stock, are considered assets of the company in question and can be seized in the event of insolvency.

Any other assets deemed to be in the company’s possession, such as real estate, equipment, and machinery, investments made in the name of the institution, and any goods that have been produced but have not been sold, are also subject to seizure and liquidation.

Without limited liability as a legal precedent, many investors would be reluctant to acquire equity ownership in firms, and entrepreneurs would be wary of undertaking a new venture. This is because creditors and other stakeholders could claim the investors' and owners' assets if the company loses more money than it has. Limited liability prevents that from occurring, so the most that can be lost is the amount invested, with any personal assets held as off-limits.

Limited Liability Partnerships

The actual details of a limited liability partnership depend on where it is created. In general, however, your personal assets as a partner will be protected from legal action. Basically, the liability is limited in the sense that you will lose assets in the partnership, but not those assets outside of it (i.e., your personal assets). The partnership is the first target for any lawsuit, although a specific partner could be liable if they personally did something wrong.

Another advantage of an LLP is the ability to bring partners in and let partners out. Because a partnership agreement exists for an LLP, partners can be added or retired as outlined by the agreement. This comes in handy as the LLP can always add partners who bring existing business with them. Usually, the decision to add new partners requires approval from all the existing partners.

Overall, it is the flexibility of an LLP for a certain type of professional that makes it a superior option to many other corporate entities. The LLP itself is a flow-through entity for tax purposes, which is also an option for LLCs. With flow-through entities, the partners receive untaxed profits and must pay the taxes themselves.

Both LLCs and LLPs are usually preferable to corporations, which are impacted by double taxation issues. Double taxation occurs when the corporation must pay corporate income taxes, and then individuals must pay taxes again on their personal income from the company.

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Watch Now: How Does a Limited Liability Partnership Work?

Limited Liability in Incorporated Businesses

In the context of a private company, becoming incorporated can provide its owners with limited liability since an incorporated company is treated as a separate and independent legal entity. Limited liability is especially desirable when dealing in industries that can be subject to massive losses, such as insurance.

An LLC is a corporate structure in the United States whereby the owners are not personally liable for the company's debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship.

While the limited liability feature is similar to that of a corporation, the availability of flow-through taxation to the members of an LLC is a feature of partnerships. The primary difference between a partnership and an LLC is that an LLC separates the business assets of the company from the personal assets of the owners, insulating the owners from the LLC's debts and liabilities.

As an example, consider the misfortune that befell numerous Lloyd's of London Names, who are private individuals that agree to take on unlimited liabilities related to insurance risk in return for pocketing profits from insurance premiums. In the late 1990s, hundreds of these investors had to declare bankruptcy in the face of catastrophic losses incurred on claims related to asbestosis.

Contrast this with the losses incurred by shareholders in some of the biggest public companies that went bankrupt, such as Enron and Lehman Brothers. Although shareholders in these companies lost all of their investments in them, they were not held liable for the hundreds of billions of dollars owed by these companies to their creditors subsequent to their bankruptcies.

What Business Structures Feature Limited Liability?

There are several company structures that feature limited liability, including a limited liability company (LLC), an S corporation, and a C corporation. Partnerships may have limited liability partners, but at least one partner must have unlimited liability.

What Is Unlimited Liability?

While limited liability separates and protects personal assets from business assets, unlimited liability means that the shareholder or partner assumes all liability for the company's success. If the company becomes insolvent, the unlimited liability partner would be responsible for repaying all debts to creditors.

Does an LLC Require More than One Owner?

No. LLCs may operate the same as a sole proprietorship with the benefit of asset protection in the event of a business catastrophe. A single person may organize as an LLC or they may have partners in the business.

In which forms of business organization are the owners personally liable for all of the debts of the business?

What is the owner's personal liability for the business?

Which organizational form of a business has unlimited personal liability for its owner?

Where the owners are not personally liable for the debts of the business?